The Nasdaq Composite has rebounded 30% in 2023, but two industry leaders are delivering even better returns. Top video game maker Take-Two Interactive (TTWO 0.72%) and streaming leader Netflix (NFLX -0.63%) have returned 38% and 49%, respectively.
These companies could be facing a run of profitable growth that could make them attractive additions to your portfolio right now. Here's what you to need to know.
1. Take-Two Interactive
Take-Two is at the cusp of a major expansion in its business, and this could send the stock higher as margins climb. It produces some of the video game industry's most popular franchises, including Grand Theft Auto and NBA 2K, among others on console, PC, and mobile platforms.
The company reported $5.2 billion in bookings (a non-GAAP measure of revenue) last year in an industry worth an estimated $200 billion.
Overall, Take-Two grew revenue at an average rate over the last 10 years, but the stock outperformed the market thanks to improving operating profit margin. Because Take-Two still generates a much lower profit margin than its larger peers in the industry, this opportunity is still in play for the next decade.
TTWO Profit Margin data by YCharts
The reason for Take-Two's lower margin has been its reliance on sales from Grand Theft Auto and NBA 2K for much of its annual sales in recent years. The company spent the last several years expanding its development staff to make more games. The goal is to build a large player base to grow digitally delivered content that players purchase while playing.
Recurrent consumer spending (the term Take-Two uses for in-game spending), which is a lucrative source of revenue, made up 79% of the company's top line last year.
As recurrent consumer spending grew over the last decade, Take-Two saw its profit margin climb to over 15%. Last year's acquisition of mobile game leader Zynga caused acquisition-related expenses to bring its profitability down, but this is only temporary.
As the company executes its game release schedule over the next few years, management expects to grow margins and achieve record operating results in fiscal 2025, which is not reflected in the current stock price.
The stock currently trades at a price-to-sales ratio of about 4.3, which is on par with the average interactive entertainment stock, but it's a discount to Take-Two's competitors Activision Blizzard and Electronic Arts.
Even if Take-Two continues to trade at its current valuation, the stock could still beat the market's return based on the above-average revenue growth over the next five years from its release pipeline. One of those will be the next installment in Grand Theft Auto -- a major catalyst.
For what it's worth, analysts expect earnings to grow at 48% per year over the next five years, which reflects management's outlook to report record financial results. Take-Two stock should continue the streak of outperformance that it's maintained over the previous decade.
2. Netflix
Netflix has bounced back following two consecutive quarters of losses last year that drove its stock price down to a low of $169. The company tapped a strong content slate in the second half of 2023 that brought in more subscribers, but the market is still not appreciating the company's opportunity to boost revenue growth from its paid sharing initiative.
Paid sharing could drive revenue acceleration and higher margins, as the company forces those viewers who have been enjoying a free ride on someone else's account to pay for their own memberships.
Management will likely have more details to share on the company's upcoming second-quarter earnings report later this month. On the last earnings call, management reported being pleased with the results after launching paid sharing in four countries in the first quarter.
A broad rollout of paid sharing was planned for the second quarter, which should be a catalyst for higher average revenue per member. Total revenue increased 8% year over year on a currency-neutral basis in the first quarter, with average revenue per member up 4%.
While second-quarter guidance calls for a slightly lower revenue increase, management said to expect even better results further out as it fine tunes the experience for members. Analysts expect full-year revenue to be up over 7% before accelerating to 12% next year.
Along with improving revenue growth, investors should expect to see Netflix continue its long-term trend of improving margins. It is already the most profitable streaming service, but management believes it has a long way to go.
Analysts are expecting the company's earnings per share to grow at an annualized rate of 21% over the next five years, which is consistent with Netflix's previous trend and reflects management's outlook for growing margins over time.
The shares trade at a price-to-sales ratio of 6.2, which can be considered fair for a high-margin business. The stock should grow in line with the company's earnings growth, which should be enough to double investors' money over the next five years.
